R&D/R&E Restored and Expanded
Section 174 of the Internal Revenue Code incentivizes investment in innovation and technological advancement by offering favorable tax treatment for businesses that engage in research and development activities. This section deals with the research and experimentation (R&E) expenses that form the starting point for calculating the research credit under Section 41.
2017 Cuts and Jobs Act (TCJA) impact on Section 174: TCJA eliminated the immediate deduction option for R&E expenses incurred after December 31, 2021. This meant that businesses needed to instead amortize these R&D deductions over 5 years if the work was done in the United States, or 15 years if the work was done outside the United States; either way, amortization was far less favorable than an immediate deduction. The net effect of TCJA’s changes hurt innovation because the tax treatment of the R&D expenditures forced business to pay taxes on amounts that didn’t truly represent a financial profit; the cash was spent, but the outlay didn’t reduce taxable income.
OBBBA Reverses TCJA’s Changes
BEFORE OBBBA: Post-TCJA
| Domestic Research & Experimental (R&E) Costs | Mandatory capitalization with 5-year amortization (mid-year convention) |
| Foreign R&E Costs | Mandatory 15-year amortization |
| Other Key Rules | Remaining basis could generally be deducted on sale/abandonment of the property. |
AFTER OBBBA: New rewrite
| Domestic R&E expensing | Mandatory capitalization repealed – taxpayers may deduct 100% of domestic R&E in the year incurred for tax years beginning after 12/31/2024 |
| Foreign R&E | No change – still 15-year amortization |
| Optional Capitalization | A taxpayer may still elect 5-year amortization, but the election is binding without IRS consent to change (this is returning to pre-TCJA) |
| Transition for other taxpayers |
All other businesses may accelerate remaining domestic R&E expenses from 2022-2024 that has not been amortized yet. Acceleration of domestic R&E expense over one to two years starting in 2025 |
| Coordination with §41 credit |
Immediate deduction is reduced by the amount of the R&D credit claimed. This has not changed. Election under § 280C remains at 21% reduction. Prevents “double benefit” |
| Basis on disposition | For property disposed/abandoned after 5/12/2025 any capitalization R&E basis may not be currently deductible or netted against sales proceeds. |
| Timing |
Amendments made the change permanent (was temporary in-House draft) § 174 was permanent before TCJA; OBBBA prevents automatically reverting to 5-year amortization. |
What This Means for You As Our Clients:
OBBBA undid the TCJA’s changes and restored immediate deduction treatment for domestic R&D expenses, although foreign R&D projects still have to be amortized over 15 years. If a company decides to claim an R&D tax credit (rather than a deduction), then the company’s Section 174 deduction gets slightly reduced.
Eligible businesses can retroactively expense R&D expenditures incurred in 2022, 2023, and 2024, rather than amortizing them over five or fifteen years as previously required. This change offers a significant immediate cash-flow benefit and opens the door to filing amended returns for prior years to claim deductions that were previously deferred. This provision offers relief to startups and growing mid-size businesses that can often be sensitive to tax-based liquidity constraints.
The R&D deduction has been supported on both sides of the Congressional aisle because it’s often viewed as embodying the American ideals of economic competitiveness, national security, and innovation policy. Unlike other provisions in the OBBBA that may face partisan scrutiny, the restoration of immediate expensing for domestic R&D is unlikely to be reversed, even under a future Democratic administration. In fact, many Democrats opposed the original TCJA legislation that required amortization of R&D expenses and have recently sponsored bills to restore the full expensing.
| Cash flow boost |
The restoration of immediate expensing lowers taxable income for tax years beginning after December 31, 2024. Qualified small businesses should review 2022-2024 returns to determine the remaining amortization amounts and how much of the amortization deductions can be accelerated into 2025. |
| Model the credit interaction | Optimize the maximum benefit for the § 41 credit and the § 174 deduction. Modeling is important because the credit lowers the deduction unless an election is made under § 280C. |
| Geography | Only U.S.–source R&E qualifies for immediate expensing. Foreign-source R&E, even if part of a domestic project, is still subject to capitalization and amortization over a 15-year period. |
| IP Disposition Plans | Capitalization R&E that remains on the books can no longer be written off upon sale of the related IP. |
DISCLAIMER: This summary is not legal or tax advice and does not create any attorney-client relationship. This summary does not provide a definitive legal opinion for any factual situation. Before the firm can provide legal advice or opinion to any person or entity, the specific facts at issue must be reviewed by the firm. Before an attorney-client relationship is formed, the firm must have a signed engagement letter with a client setting forth the Firm’s scope and terms of representation. The information contained herein is based upon the law at the time of publication.
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